The unfortunate math behind consulting companies

While I agree with the general "consulting is not the path to riches" tone of the article, I have a small nit.<p>What the author is doing is adding up all the worst case scenarios into one big ugly pile of bad.<p>It reminded me of an mp3 player I designed once. I had to allocate z-height for the LCD. An LCD can have a lot of subcomponents (EL Backlight, FPC cable, rear reflective film, glass, front polarizing film, plastic protective lens, etc. All of these have min/max dimensions on the spec sheet. An inexperienced engineer, such as I was, would just add all the max dimensions to get max z-height of the LCD and design for that. But I also needed it not to rattle around, so I needed my design to also work if all the dimensions came in at their minimum. Woops! It's thickness could apparently vary wildly. I didn't want to burden my product with the complexity it would take to handle so much variance in one component.<p>I then learned that tolerances are never added up "worst case" or you'd never get anything built. Instead, you do a root mean square of them. The chances of every component in your subassembly coming in at it's absolute maximum are minuscule. The root mean square method accounts for this.<p>Anyway, I felt that the author of this piece was doing a little max tolerance stacking.

I think the author of this article has <i>no</i> experience with consulting companies. $100/hr is well below what Accenture, IBM Global Services or any of the other big names charge. And clients, by and large, are fine with it; it's just a cost of doing business. And it's hard to argue that any of them haven't "scaled"; Accenture is 200,000 people!<p>Remember, in business there is no such thing as "cheap" or "expensive". There's "worth the money" or "not". A decision maker has decided that paying a consulting firm $250/hr/consultant is cheaper than it would be to do their own SAP implementation (and in turn, that SAP is worth more than it costs...)<p>FWIW a consultant as a rule of thumb would probably see 1/5 of his billing rate, tho' I have seen some get 1/3 and some as low as 1/8.

I long time ago I was playing bridge with a genius named Arno Hobart. I asked him what he was up to, and he told me he was in the vending machine business. "Oh?" I asked, surprised that such an intelligent man would work with such mundane products.<p>"One of the things I like about this business," he explained, "Is that I make money while I sleep." Yes, he really is smarter than the average bear.

i've grown from 1 (me) to 10 since october. we're trying to scale and it's tough. i'm exhausted. i'm working A LOT. i've got too many clients... but i can see the light toward having a stable set of clients with solid revenues - and i'm creating jobs for 10 people in a developing country, which i'm getting more satisfaction out of than i thought i would.

There's no leverage in consulting. Granted. Doing it anyway - as long as I'm working for the man, I want to be the man.

I really like most of Jason Cohen's posts, so this article is especially disappointing.<p>The most fundamental problem with Cohen's analysis is how he arrives at bill rates. "Everybody knows", he says, "that your consultant isn't worth $100/hr --- you only pay him $30/hr!". Well, no, Jason. Nobody knows that, because it's not true. Companies that engage consultants pay a significant premium to: (a) retain talent for the exact duration that they need them, (b) on often little-to-no notice, (c) with the flexibility of picking and choosing the right consultants for the right jobs (d) with no obligations on benefits and severance. And the consulting market is more liquid than the employment market (full-time jobs are "sticky"), so prices more closely track value.<p>So it is the case that an hour of Rails/jQ consulting might bill out at $140, while the talent delivering that work might effectively make $40/hr. The talent is, in addition to base comp, also getting a stable job, experience working alongside iPhone developers sharp enough to start a successful consultancy, health, benefits, and all the other things that are the reason that big companies have to pay so much to staff projects.<p>This model works so well that there are branches of the industry that are difficult to staff outside of consulting. For instance, the very <i>very</i> high end of software security bills north of $400/hr. Even discounting for FTE benefits, nobody can afford that person full-time. This sets up a virtuous cycle whereby consultants amass expertise, drive scarcity in their field, and increase their comp.<p>It should also go without saying that when your bill rate is very high, you don't need to add consultants to make time for product development. You can work half-time and still beat a bigco salary.<p>The rest of Cohen's arguments are somewhat blunted by the fact that the underlying economics of consulting are <i>way</i> better than he thinks they are. To wit:<p>* The cost of fully loading headcount isn't scary when you're priced properly.<p>* Similarly, if you price with the market, the cost of "scaling" isn't scary. Offices are cheap compared to salaries.<p>* Most consulting firms deliberately aim to keep utilization below a threshold, and recruit to "cool off" when things get crazy. 40 hours a week, 50 weeks a year isn't desireable even as an owner.<p>* Lots of consultants have written blog posts about firing dysfunctional bigco clients. Yeah, in the real world, you have to deal with the 25 page MSA contracts; that's what you pay lawyers for. Yes, being in business is annoying. If it wasn't, everyone would do it.<p>* Yes, it's hard to build and ship products in "off hours". But you don't have to do that. Instead, you can scale to the point where it's cost effective to hire full time developers. Most YC companies get to market with 2-3 team members. It isn't a stretch to scale a consultancy to the point where it can fund 2 developers.<p>Against all these concerns about consulting is the unbelievably huge upside of bootstrapping a company this way: you get near-unlimited lives. It is the JUSTIN BAILEY of startup plans. In virtually every other model of bringing a product to market, product failure ends the company. That's bad, because most products fail. They really, really do. There is no reason that a product miss should zero out all the hard work you put into building a team and a business.

My initial reaction to this article was that I disagreed vehemently with most of his points. Upon further reflection, nothing he's talking about is applicable to anywhere I've worked, or anywhere in the industry I work in; so my disagreement doesn't really matter as I guess "consulting companies" apparently means different things to different people.<p>The only issue that presents itself in my industry regarding consulting is that it's basically a linear scaling revenue model, and the pitfalls around scheduling engagements.<p>My company's hourly rates for consulting are now about half of what they were 7 years ago, but it's still both immensely profitable and significantly cheaper than what the client would pay to hire someone to perform the requisite services.

eh, I have done this... contracting paid for prgmr.com. And really, I've had a /whole lot/ more luck renting myself out and paying people to work on my product than renting out my underlings. So yeah, I think he has many good points.<p>On the other hand, some of the problems of being a contracting company and being a product company cancel themselves out. You have time you can't sell to other people? work on developing new features for the product. Hiring someone new who you aren't sure about or who needs training? Pay them trainee wages while training them up as they work on the product, then as you know their capabilities, rent them out.<p>But overall, I agree with the "renting yourself out at exorbitant rates is easier than renting out your underlings" advice, though this is at least partially due to a lack of sales skills on my part; but yeah, there are a lot of less obvious costs to renting out an employee.

Ugh, I've seen small-town web development shops charge $130+ an hour for work done by the grunts who get more like $30 an hour.<p>Some of these shops are very profitable and successful, and some of them aren't.<p>Either way, the person who's got the most to complain about this situation is the grunt, not the customer who imagines they could get the work for cheaper. The grunt is very aware that he could produce a lot more value for someone, and capture it, if he can get rid of the middleman. Although the work in a consulting shop is varied, and can keep you on your toes, the need to bill 40 hours of project time every week leads to a lack of self-investment and eventual burnout.

This article generalizes too much. Top Indian IT giants are consulting companies and they are making a ton of money.

You have to share the upside with your consultants, put a target to bill 1200-1500 hours per year depending on your average engagement length and how much they will have to be on pre-sales work. Then split every hour after that with them 50/50% up to 2000 billed hours and after 2000 hours billed give them 75%, keep 25%.<p>I know tech folks love to reinvent and learn things on their own and sometimes it yields new and better results but in other cases we'd be better off to look at how BigLaw has been billing out hourly associates for hundreds of years very profitably.

This just made me very depressed. Very, very depressed, because it hit so close to home.

Thanks for sharing your thoughts. This kind of analysis is required for any service business. Having done so for our company, I have the following observations on 'What to do?":<p>Scale -- Bingo! The goal is to make the fixed overhead (incl employees) an increasingly smaller percentage of revenue. But to handle the increased revenue (ie, workload) you have to concentrate on increasing efficiency/productivity. This has a lot of influence on decisions about process. Obviously, the more routine those processes are, the cheaper (and more easily replaced) the labor can be. Also, if the work is done under a fixed price contract, you can achieve a greater effective hourly rate if you are efficient and manage risk well.<p>Charge more -- "charging more pushes away your existing client base". This is not such a bad thing if you have your eye on 'scaling' (ie bigger projects). Bigger clients have deeper pockets (although they also have more unique needs, which introduces more risk).<p>Build a product -- See Nassim Taleb's discussion about 'scalable work' in "The Black Swan". The odds aren't good that this will pay off.

I still find it weird that people charge an hourly rate. My company has been doing fixed price projects, with changing scope, guaranteed bug fixes &#38; payment on delivery for the last eight years. We regularly beat out the "big boys" and have never lost money on a project, even though some have gone on longer than we planned.<p>I don't see the value for a customer in an hourly rate. If I am charging you by the hour, I have an incentive to be slow. If I am charging fixed price, I want to be fast, and if we are "liable" for bugs, we have an incentive for bug free code.<p>I see it as putting our money where our mouth is. I'm confident that <i>even if your scope changes</i> we will still deliver for this fixed price. Why is this not the norm?

While some of these issues will happen from time to time, all of those exceptions will not occur all the time, so it really isn't an accurate assessment. This is more like the worst possible bounds of a successful consulting company.

While most people disagrees but my experience was different. I used to work with a US firm years ago and my hourly rate was $12 however our company charged $80 to $120/hr to our clients. This is how offshore companies operates...

This is hard to pull off - but I think part of the solution is in somehow not competing with the average employee that you can get on the street.<p>For example, you can provide a skill that is not otherwise generally available on the market. Or perhaps by doing consulting but on a closed source product (by doing a per project sale instead). It will be great to brainstorm other such ideas and approaches.

Somebody clarify the tax portion for me on this ... Don't companies only pay half of social Security and Medicare on each employee? ... plus the employee is also a tax writeoff for them right?<p>So is that 15% number accurate?